Why Reinsurance?

IndianMoney.com Research Team | Monday, April 06,2009, 07:24 PM

Why reinsurance is important:

1. What is reinsurance?

It is process whereby one company or the reinsurer takes on all or part of risk covered under a policy issued by an insurance company in concern of a premium payment. In other words, it is a form of an insurance cover for insurance companies. Reinsurance is different from co-insurance where some insurance companies come together to issue one single risk, reinsurers are naturally the insurers of the last resort.

2. Why do insurance companies reinsure?

The companies buy insurance, to defend their balance-sheets from unforeseen losses. The insurance business is based on laws of probability, which pre-supposes that only a portion of the policies issued by them would result in claims. The premier are fixed in such a manner that the total premium collected would be enough to pay for the total claims incurred after providing for expenses.

Though, there is a possibility that in a bad, year full cost of claims may be much more than the premium collected. If the losses are of a very large magnitude, there is a chance that the net worth of the company would be wiped out. It is to evade such risks that insurance companies take out policies.

Insurance companies take the support of reinsurers when they do not have the ability to provide a cover on their own. Prudential norms prescribe the greatest risk that an insurance company can take on its own books in relation to its net worth. Under such circumstances, the company has to go in for reinsurance support.

3. How do insurance companies make money if they pass on their premium to reinsurers?

Insurance companies never pass on their total risk to reinsurers. They retain a part of the risk and the premium on their own books. As insurance companies do all the ground work, they are paid a commission by the reinsurers, which can be a substantial amount.

4. What are the types of reinsurance?

Reinsurance can be classified into two: treaty reinsurance and facultative reinsurance. Treaty reinsurance provides a blanket security to the insurance company for total claims above and up to a pre-determined limit.

The insurance company does not have to submit the facts of the policies it has issued, only a statement is issued at the end of the year basis on which claims are established.

A facultative reinsurance cover is one that is taken specific to a certain cover, for example, a large oil refinery. Here, the reinsurer will conduct the same due diligence normally conducted by an insurance company, spell out the terms of coverage and quote his charges before accepting the risk.

If three parties, insured, the insurance company and the reinsurance company, agreed on some terms, then a policy is issued with the reinsurance.

5. What is the reinsurance market?

Reinsurance companies generally work in concert. In reinsurance also, there are specialists in aviation and energy. Reinsurance is dominated by a handful of very large companies.

6. Who will lose money in the losses arising out of the recent attacks in the US?

If such event occurs, at the first instance, most of the losses will have to be borne by the reinsurers. Since the reinsurance business is restricted by a clutch of few very large companies, it will see their reserves falling sharply. This fall in reserves will decrease their capacity to take on fresh reinsurance proposals.

The capacity also shrinks if there is a recession in the financial markets and the value of the reinsurance company’s reserves fall. The reinsurers will then try to build up their reserves by hiking rates sharply. Thus, ultimately the insurance companies may end up paying for the losses through higher reinsurance premium.

7. What is the use of reinsurance?

Over a definite period of time, an insurance company may be able to pay all its claims. But, these claims may not be spread evenly over the year, and may instead come in peaks, such as all in one month. A reinsurance agreement allows the reinsured to smooth out its claims and to reduce some of the uncertainties.

• To protect against losses from a single catastrophic event A single event, like a flood, could affect all the insurance clients and create more claims than the insurance company can handle. The international nature of reinsurance enables risks to be extending across national boundaries.

• To reach more clients Insurance companies decide how many clients they can serve based on how much they can comfortably lose. Reinsurance allows insurance companies to absorb higher losses and to issue extra policies to its clients

8. What types of reinsurance are available?

Following are the types of reinsuranceare available: pro rata and non-proportional.

a. Pro rata or Proportional : In a proportional agreement for reinsurance, the reinsurer agrees to pay for losses in the same proportion as the share of premium it receives from the reinsured.

b. Non-proportional / Excess of Loss : In non-proportional reinsurance, the reinsured agrees to pay all losses up to a fixed figure. The balance of any loss that exceeds this agreed amount is called as the retention or deductible, will be met by the reinsurer, subject usually to a pre-agreed maximum. The price or premium paid is determined by a rate or amount that the reinsurer considers adequate to cover potential liabilities, taking into consideration a number of factors.

The difference between proportional and non-proportional insurance is that proportional reinsurance focuses on the nature of the overall risk, but non-proportional reinsurance focuses specifically on the potential loss to the reinsurer

9. What are the two types of reinsurance contracts?

There are two methods of placing the forms of reinsurance: facultative and treaty.

Facultative means that the reinsurance arrangement is not obligatory. Each individual risk must be presented individually and is considered on a case by case basis. The reinsurer has the right to accept or reject each risk.

A Treaty is an agreement where the reinsurer agrees to accept the reinsurances on all the risks that fall within the terms of the treaty. The reinsurer will not review individual risks and is compelled to accept the risks that are covered by the treaty.

10. What does a reinsurer consider when underwriting?

• Legal status of the reinsured Most reinsurer companies are bound by internal and government rules and regulations to only deal with fully licensed insurance companies.

• Type of risk to be insured

The reinsurer will do a systematic analysis of the risk that has been insured by the reinsured. It will want to realize the type of coverage provided by the insurer – what is reimbursed and under what conditions. It will examine the probability of a loss, the expected frequency of claims, and the magnitude of potential losses. This study allows the reinsurer to understand how risky the insurance portfolio is and therefore how to structure the reinsurance contract.

• Premium pricing of the reinsured The premiums charged by the reinsured to its insurance client will factor into the reinsurer’s analysis and will influence the premium that the reinsurer charges the reinsured.

• The exact wording of the reinsurance contract The contract needs to detail very particularly the terms of the agreement. In particular, the extent of the coverage that is what risks are covered, what risks are not, what are the exceptions to the agreement needs to be clearly outlined.

• Financial status of the reinsured

The reinsurer will understand that the primary insurer is in good financial health and will be able to realize its payment obligations by, among other things, looking at the ceding insurer’s financial statements and the auditor’s reports.

11. What should company consider when choosing a reinsurer?

Company may decide to obtain reinsurance, the following factors should be considered :

• Price (premiums paid to the company by the reinsurer in order to assume the risk) The company must make sure that the contract covers the risks that it is looking to reinsure. The contract needs very specially detail the terms of the agreement. In particular, the extent of the coverage needs to be clearly outlined. The contract wants to explicitly define each party’s responsibility for costs, the legal recourse in case of disputes and the contract renewal procedures.

• Willingness and ability of the reinsurer to pay The company has to be comfortable that the reinsurer will be willing and able to fulfill its obligations under the reinsurance contract. The company wants to review the reinsurer’s financial status, understand its past history in paying claims, its insurance rating if available, and what kind of risk it has underwritten

12. What happens if I leave Reinsurance?

The bank remains entitled to receive dividends until all of its business has expired.

13. Why should I join Reinsurance?

There is no downside to joining Reinsurance, but various possible benefits. With Reinsurance your commissions will remain the same, and you can receive extra income in the form of dividends based on your bank’s underwriting experience.

14. What are the types of Insurance and Reinsurance intermediary?

A reinsurance intermediation means a person who, for remuneration, undertakes or purports to accept reinsurance mediation;

Reinsurance mediation means work undertaken in connection with entering into contracts of reinsurance, work undertaken preparatory to entering into such contracts, introducing persons to reinsurance undertakings or other reinsurance intermediaries with a view to entering into such contracts, or supporting in the administration and performance of such contracts but does not include the following :

The Work undertaken by a reinsurance, undertaking or an employee of a reinsurance undertaking in the employee’s ability as such, or providing information on an incidental basis in conjunction with some other professional activity, so long as the purpose of the activity is not to assist a person to enter into or carry out a reinsurance contract, or Managing claims of a reinsurance undertaking on a professional basis, or failure adjusting or undertaking expert appraisal of claims for reinsurance undertakings.

15. Do I need any qualifications to become a reinsurance intermediary?

The qualifications or experience requisite depends on the service you intend to provide to your consumers. Full particulars can be found in the Minimum Competency Requirements.

16. How will I know if my application has been received?

The Financial Regulator within 2 days of receipt sends a written acknowledgement of receipt of all applications

17. What do I need to do if I no longer wish to hold reinsurance intermediary registration?

If intermediary wish to terminate registration as a reinsurance intermediary, he/she need to provide the Financial Regulator with a written request for cancellation of their registration and return the original document of your registration.

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IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.